An organization sustains itself by receiving money for its goods and services while spending on its ability to produce those goods. Accounts payable and receivable is a concept that is the same thing but has more layers. If you are a business, then accounts receivable and accounts payable are something you should add to your knowledge.
Almost all lenders and potential investors look at accounts payable and account receivables to judge the company’s situation. If they found them in a good equilibrium, it is good news for you. If not, then not so much. Today we’ll be telling you all there is to know about these concepts and how you can effectively manage these to maintain the stability of your business. Here’s everything you need to know about accounts payable and receivable.
What essentially is Accounts Payable (AP)?
Accounts payable (AP) is the amount you or your company owes to its suppliers or other creditors at a basic level. If your organization made a hefty investment, its payment might be considered part of accounts payable. Although accounts payable do not include payroll or long-term debt like a mortgage, it does consider expenses covering those long-term debts.
For example, if you buy an expensive smartphone on EMI, i.e., equated monthly installment, its total cost won’t be a part of accounts payable. However, the amount you pay each month will be considered in AP.
Receiving an invoice based on payment terms agreed to by both parties becomes what we record as account payable. The finance team of the company gets this bill for goods and services. They then record it as a journal entry and post it to the general ledger as an expense. As mentioned, accounts payable cover the expenditure that your company is making. However, the balance sheet shows only the total amount of accounts payable and not individual transactions.
● Characteristics of AP departments
After the payment has been done as per the contract terms and an authorized approver confirms this, the accounting records the expense as paid. AP departments are a crucial part of an organization and are responsible for processing expense reports and invoices and ensuring that payments are being issued on time.
A skilled AP team helps your company maintain a positive supplier relationship by keeping everything from updating vendor information to paying the bills on time. They also look for payment terms that favor the company and constantly hunt for discounts that save the company money.
● Two ways to record Accounts Payable
Companies can use the two most common ways to record accounts payable: accrual or cash-basis accounting. Accrual accounting allows finance teams to make unpaid expenses act as placeholders for cash events. On the other hand, cash basis accounting will enable companies to record the costs after paying the suppliers.
Accounts Receivable (AR) explained
Accounts receivable can be considered as the opposite of accounts payable. They are the funds that customers owe your company, for example, credits for products or services that your company provides. The total value of accounts receivable is also available on a balance sheet. Therefore, they are termed “current assets” on the balance sheets.
As the term might suggest, accounts receivable include all invoices that your client owes for items or services performed for them. Often, vendors tend to bill customers after providing services or products. This also happens when a contract between the two parties is signed and mutually agreed on terms. Generally, customers agree to pay a net 30, i.e.; they pay within 30 days. Net 60 and net 90 are also some available options.
● Accounts Receivable team
After the company delivers the goods or services promised to the client, the AR(accounts receivable) team sends the customer invoices and records the amount as account receivable. The team shifts the payment from receivable to deposit after the client has paid according to the contract. After that, the amount is no longer receivable. However, if customers fail to pay on time, the team must send a dunning letter and the original invoice with some late fees, if any.
● How Accounts Receivable are recorded
Accrual accounting makes it so that your receivable balance is termed under current assets. After invoices are paid, the appropriate liabilities accounts are credited by finance, and they also debit accounts receivable to account for the payment.
If we see it from one person’s perspective, every invoice that is made is payable for one party and receivable for another party. Both are recorded in the general ledger, one as a liability and the other as an asset. The company’s financial health depends directly on the status of these two.